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Copyright 2005. All rights reserved.

Accounting Topics

Rules of Double Entry
Assets, Liabilities & Capital

What do we mean by ASSETS, LIABILITIES and CAPITAL?

ASSETSLIABILITIES

Something a business owns.

Examples:

Buildings

Premises

Equipment

Motor Vehicles

Stock

Debtors

Bank

Cash

Something a business owes.

Examples:

Bank overdraft

Trade creditor

Loan

Capital

We can also distinguish between FIXED ASSETS and CURRENT ASSETS, and between LONG TERM LIABILITIES and CURRENT LIABILITIES.

Note that CAPITAL is just another LIABILITY (it is referred to separately because it is what is owed to the owners (or proprietors) of a business.

In other words:

'Assets' is a term representing:

  • items owned by a business (e.g. buildings, stock), and
  • claims on assets apparently sold but which are still owned by the business because they have not yet been paid for (e.g. debtors, representing stock sold on credit terms).

There are two kinds of asset: FIXED ASSETS and CURRENT ASSETS. Click on these links for lists of examples.

'Liabilities' is a term representing:

  • items owed by a business (e.g. loan, overdraft), and
  • claims on assets apparently bought but which are not yet owned by the business because they have not yet been paid for (e.g. creditors, representing stock bought on credit terms).

There are two kinds of liability: CURRENT LIABILITIES and LONG TERM LIABILITIES. Click on these links for lists of examples.

'Capital' is a term representing what is owed by the business (a searate entity i.e. treated as being totally separate from the owner or proprietor, whether sole trader, partnership or limited company). Capital then is another kind of liability.

The Accounting Equation states:

ASSETS = CAPITAL + LIABILITIES

The important point to note here is the equals sign denoting that this is an equation. Withouy going into a detailed consideration of the mathematically reasoning, we know that when we move an item from one side of an equation to the other, then its power or operation changes i.e. a 'plus' becomes a 'minus'. This rationale underpins the book-keeping treatment of assets (one side) and capital and liabilities (the other side).

If we accept that when we record a change in value of an asset, we do the OPPOSITE to record a likewise change in capital or liabilities (on the opposite side of the equation).

The double entry book-keeping rules can thus be summarised as:

 ASSETS = CAPITAL + LIABILITIES
IncreaseDEBITCREDIT
DecreaseCREDITDEBIT

The increase or decrease represents the two possible changes in value when a financial transaction takes place.

Note that the RULE OF OPPOSITES applies here (as in all double netry transactions) and helps us decide what to do when recording any transaction involving assets, liabilitities or capital.

All we have to remeber from the above table is that an increase in an asset is a debit. from this basic knowledge we can deduce what to do about decrease in assets or indeed, increases or decreases in liabilities and/or capital. This basic truth makes accounting more than just a learn and churn subject, but insetad a skill, and one worth learning at that (it is even enjoyable deciding what to do because you are in effect solving simple puzzles as you work your way through a problem, to arrive at a solution to an overall much more comples situation - magic!).

Example 1:

Purchase of a motor vehicle (fixed asset) for cash (current asset)

In this instance an asset (motor vehicle) increases in value (DEBIT) and another asset (cash) decreases in value (CREDIT).

Insert ledgers and amounts etc

Double entry rules for assets, liabilities & capital

The rules of double entry always cause students concern! What does DEBIT and CREDIT mean?

It is really not as difficult as it all sounds!

First, we record all financial transactions in records called accounts, and we always record every transaction twice (double entry book-keEping).

We record one entry on the left hand side of one account and the other entry on the right hand side of the other account.

We call the left hand side of an account the DEBIT SIDE and the right hand side the CREDIT SIDE.

When we say DEBIT an account we simply mean that we are recording one half of the double entry on the LEFT hand side of an account.

When we say CREDIT an account we simply mean that we are recording one half of the double entry on the RIGHT hand side of an account.

So what are the rules to remember regarding ASSETS, LIABILITIES and CAPITAL?

The table below summarises what we should do when recording entries, remembering that every transaction has two parts, and this means one entry on the LEFT (DEBIT) side of one account, and one entry on the RIGHT (CREDIT) side of another account.

 ASSETSLIABILITIESCAPITAL
IncreaseDebitCreditCredit
DecreaseCreditDebitDebit

You will hopefully have recognised a pattern here involving what I call the RULE OF OPPOSITES.

If we do one thing to an asset the we do the opposite to a libility, and vice versa!

So if we can remember to DEBIT an ASSET when it increases in size we should be able to work out what to do if a LIBILITY also increases.

EXAMPLE

On 2nd January a business buys a Motor Vehicle for £5,000, paying by cheque.

First we identify which accounts need to be used - here Motor Vehicle (an asset) and Bank (another asset - bank used because the cheque is an instruction to the bank to pay someone from your account).

The double entry then becomes:

DEBIT Motor Vehicle £5,000 (an increase in the value of Motor Vehicles)

CREDIT Bank £5,000 (a decrease in the value of funds in the bank)

Motor Vehicles

Debit sideCredit side
2nd Jan Bank £5,000 

Bank

Debit sideCredit side
 2nd Jan Motor Vehicles £5,000

If you were to read these accounts you would see from the Motor Vehicles account that Motor Vehicles had been bought and paid for using funds from the Bank.

If you were to look at the Bank Account you would be able to see that funds from the Bank had been used to buy a Motor Vehicle.

Every financial transaction has two parts and these are recorded in their respective account.

More Examples

EXAMPLE involving INCREASE in an ASSET and DECREASE in an ASSET

On 2nd January a business buys a Machine for £3,000, paying by cash.

First we identify which accounts need to be used - here Machine (an asset) and Cash (another asset).

The double entry then becomes:

DEBIT Machinery £3,000 (an increase in the value of Machinery)

CREDIT Cash £3,000 (a decrease in the value of funds in the cash box or till)

Machinery

Debit sideCredit side
2nd Jan Cash £3,000 

Cash

Debit sideCredit side
 2nd Jan Machinery £3,000

If you were to read these accounts you would see from the Machinery account that Machines had been bought and paid for using cash.

If you were to look at the Cash Account you would be able to see that cash had been used to buy a Machine.

EXAMPLE involving INCREASE in an ASSET and INCREASE in a LIABILITY

On 22nd January a business buys equipment costing £70,000 on credit terms from Garth Stimpson (a creditor).

First we identify which accounts need to be used - here Equipment (an asset) and Garth Stimpson - Creditor (a liability).

The double entry then becomes:

DEBIT Equipment £70,000 (an increase in the value of Equipment)

CREDIT Garth Stimpson £70,000 (an increase in what is owed to a creditor)

Equipment

Debit sideCredit side
22nd Jan Garth Stimpson £70,000 

Garth Stimpson - Creditor

Debit sideCredit side
 22nd Jan Equipment £70,000

If you were to read these accounts you would see from the Equipment account that Equipment had been bought on credit from Garth Stimpson.

If you were to look at the Garth Stimpson Account you would be able to see that he was owed £70,000 in respect of equipment obtained from him.

EXAMPLE involving DECREASE in an ASSET and DECREASE in a LIABILITY

On 28th January a business pays Garth Stimpson (creditor) a cheque for the £70,000 he is owed.

First we identify which accounts need to be used - here Garth Stimpson - Creditor (a liability) and Bank (an asset).

The double entry then becomes:

DEBIT EquipmentGarth Stimpson £70,000 (a decrease in what he is owed)

CREDIT Bank £70,000 (a decrease in the amount of money in the bank)

Bank

Debit sideCredit side
 28th Jan Garth Stimpson £70,000

Garth Stimpson - Creditor

Debit sideCredit side
28th Jan Bank £70,000 

If you were to read these accounts you would see from the Bank account that Garth Stimpson had been paid £70,000.

If you were to look at the Garth Stimpson Account you would be able to see that he was paid £70,000 by cheque.

EXAMPLE involving INCREASE in a LIABILITY and DECREASE in a LIABILITY

TO DO

Reasons why we DEBIT and CREDIT assets, liabilities and capital when we do.

TO DO


Now try these great graded activities to further develop your skills, knowledge and understanding:

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